We all know how the risk of unregulated hedge fund/derivatives markets like CDS and CDOs contributed to this problem. We need both more regulation and smarter, better enforcement of existing regulation.posted by ornate insect at 8:01 PM on June 17, 2009 [3 favorites]

But will the proposed measures adequately address the causes of the current crisis?

Quite possibly. But they won't do a thing about the causes of the next crisis.posted by infinitewindow at 8:33 PM on June 17, 2009

Remarks given at the IIF meeting by the suave Liu Mingkang, head of the China Banking Regulatory Commission (CBRC) since its creation in 2003, suggest that there is another reason to be relatively sanguine about the health of the Chinese financial system: its regulators appear to have a better idea of what they are doing than their western counterparts.
In contrast to western regulators, who put bank regulation on auto-pilot via the model-driven and extremely pro-cyclical Basel II capital adequacy system, Mr Liu made a persuasive case for the enduring value of old-fashioned bank supervision tools such as limits on single large exposures, a conservative 75 per cent loan-to-deposit ceiling, limits on simple leverage ratios, and “window guidance” on exposures to specific companies and sectors.
As Mr Liu cogently summed it up: “Basel II is problematic; traditional ratios are still useful. Small is beautiful and old is beautiful as well.

Its almost 90 pages, and I've only managed to get through it once at a very high level so far, but the article's summary presents a neat list of bullet points, many of which are in urgent need of being fleshed out.

Create a Financial Services Oversight Council

Implement Heightened Consolidated Supervision and Regulation of All Large Interconnected Firms

Strengthen Capital and Other Prudential Standards For All Large Banks and BHCs

Its very high level. Haven't seen too many details that would allow me to carry out a Quantitative Impact Study (like we did while adopting Basel II; these allow us to calculate balance sheet impact under two different regulatory scenarios).

Page eight pumps the United States' role in the G20, global financial leadership and specifically mentions Basel II; curious, but its well known US Banks successfully lobbied The Fed / et al to delay the rollout of Basel II, instead introducing a watered down version that in the industry is called Basel 1.5

One of the new agencies, The Financial Services Oversight Council, is charged with advising The Fed on firms deemed to big to fail, and how they might increase systemic risks (page nine). This is instead of consolidating existing regulatory agencies, perhaps strengthening some and weakening others. Not sure how this will play out in practice; a key concern (and please keep in mind this is very premature) would be entrenched agents playing off one agency against another.

Page ten and twenty three both discuss removing constraints imposed on The Fed by the Gramm-Leach-Bliley Act (GLB) which I can only view as a positive; now an institution can be audited by both State regulators, The SEC as well as The Fed. Good one.

First of all, the Chinese regulators have to employ very, very conservative standards as, from a financial reporting point of view, the country is a mess. I used to run a large group with responsibility for some parts of China, and it wasn't until we put our own people on the ground that we could get an accurate view of what was really on the books of their banks. And even then we had to get people to physically verify - that means get on a train and GO - those assets existed.

So they must employ very, very conservative regulations as they simply don't know what is really on a banks books or not.

Second, in discussions of matters financial, I find words like "extremely" (i.e, and extremely pro-cyclical Basel II capital adequacy ) in appropriate. It is or it isn't pro-cyclical. Subjective words like "extremely" don't apply.

But his observation is hardly ground shaking; in fact Jamie Dimon said pretty much the same well over one year ago when he discussed the pro-cyclical nature of virtually all policies, actions and events.

Previously Warren Buffett opined that Jamie Dimon's summary of 2008 in his 2008 Annual Letter to Shareholders was "a masterpiece", and should be read by everyone with an interest in the financial crisis.

Page seventeen, section E is a very, very cogent and easily accessible three hundred (or so) word summary of what Liu Mingkang was really trying to say. He should have just directed everyone to JP Morgan's 2008 Annual Report.posted by Mutant at 5:38 AM on June 18, 2009 [5 favorites]

bukvich: See, I think that comment you linked is superficial and over-simplistic in its analysis, getting one of the key premises of this whole financial sector reform effort wrong in a pretty fundamental way. The intent of these regulations isn't to eliminate risk, and I don't think they do "propagates the myth that all (global) monetary flows can be made completely riskless."

The point of the new regulatory regime (at least as I understand it) is to minimize systemic risk by forcing the individual actors in the financial sector to internalize as much of their own risk as possible.

Think of the financial system as a network, like an electrical grid. Our current financial system has too many interdependencies among the various institutions (nodes) in the network. Take out one or two key nodes, and the power goes out everywhere (i.e., money stops flowing).

Sure, there will always be risk in the system, in the sense that any individual node in the network could fail, but there shouldn't be any reason for isolated failures to trigger global failure on the scale we've seen during the financial crisis.

The aim of the new regulations is to make the financial system as a network (continuing with that analogy) more robust and stable. Doing that requires isolating more of the risk within each node and implementing new fail-safe mechanisms.posted by saulgoodman at 9:46 AM on June 18, 2009

First of all, the Chinese regulators have to employ very, very conservative standards as, from a financial reporting point of view, the country is a mess. I used to run a large group with responsibility for some parts of China, and it wasn't until we put our own people on the ground that we could get an accurate view of what was really on the books of their banks. And even then we had to get people to physically verify - that means get on a train and GO - those assets existed.
But there's the thing Mutant, (and cheerfully admit this is well outside my area of expertise) recent events have shown that in fact Western finance was not short of lies and non-existent assets itself, yet saw fit to lecture China on its particular problems. Hard to begrudge them a bit of crowing now as they watch the self-delusions of the West bite a big chunk out of its arse.posted by Abiezer at 9:51 AM on June 18, 2009

I don't want to be simplistic, and god knows I don't have the technical knowledge to assess the outcome of these changes, but my feeling is the change needed is a principles based regulatory environment, rather than a rules based one. These rule changes may precisely address issues with the current CDS market (for example) , but a principles based approach, like in the UK and Commonwealth has the advantage of constraining the next generation of financial engineering schemes.
Well, at least I believed it did a better job, but the UK banks seem determined to prove me wrong.
In theory, a financial operator using methods that may be in question under a principles based regime has a higher risk profile than a similar scheme that is judged within fixed rules. If the market was efficient in measuring this type of risk, a principles based market would evolve a lower risk profile than a rule based one. I guess one thing the last 18months has proved is that the market tends to assume copliance is a zero cost.posted by bystander at 7:22 AM on June 19, 2009

Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.

I've gotta say--while I have qualms about some other aspects of the proposals--the motivations for postponing concrete proscriptions in this particular area seem pretty obvious to me: the administration hopes to get the beefed-up regulatory powers (which it probably views as higher priority) enacted first, and wants to avoid having the more controversial reforms (like new rules on executive compensation) from derailing the entire reform effort before it even starts.

The main criticisms I've heard that seem harder to dismiss are that the proposed reforms basically just give more authority to the Federal Reserve--which arguably botched the job in the first place, and is closely aligned with the giant banking institutions that created this mess--and that they don't really do enough to streamline the current patchwork of overlapping regulatory bodies. I'd personally like to see an independent regulatory body, with no representation from the banking industry, granted authority over the other regulatory bodies and to oversee the financial sector from a systemic risk perspective.

I'd also like to see anti-trust laws enforced more vigorously, and a massive (at least) one-time tax hike on the rich. But then, I'd also like to see our country stop endlessly repeating destructive and destabilizing foreign policy mistakes like meddling in the internal affairs of other sovereign nations and breaking virtually every international treaty it signs for short-term tactical gains. But those things probably aren't ever going to happen either.posted by saulgoodman at 9:51 AM on June 19, 2009

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